Banks, Supervisors Must Balance Responsibilities, Says Fed Governor Raskin

Banks, Supervisors Must Balance Responsibilities, Says Fed Governor Raskin

Photo of Sarah Bloom RaskinA critical step to a more effective bank supervision program is finding the right balance of responsibilities between banks and supervisors, said Federal Reserve Governor Sarah Bloom Raskin during an April 7 speech.

Although the recent crisis underscored the need for more effective regulation and a new approach to bank examinations, "banks have a fundamental—arguably the fundamental—role to play in improving financial system resilience," she explained.

Bank management plays key role in safety, soundness
To Raskin, a healthy bank resembles a series of concentric circles, with the inner rings representing the bank's systems and functions. Core to this model is the bank's corporate governance structure, including senior management and the board of directors. This group plays a critical role in promoting safety and soundness by establishing parameters regarding activities and behaviors that are either encouraged or discouraged, she said.

Similarly, well-informed managers and employees contribute to safety and soundness, too. This is especially true of community banks, she said, where employees' deep knowledge of the business and customer base can help them identify problems before they spread.

Other equally important functions and processes, including enterprise-wide risk management programs and strong internal audit functions, form the remaining inner rings, she said.

Supervision shores up inner rings
While the concentric circle model emphasizes the role of banks in identifying problems that pose a threat to safety and soundness, supervisors also have important responsibilities, explained Raskin. However, she warned that banking supervision "was never intended to be a subsitute for a bank's own risk management processes, nor should it be."

Effective supervision is made up of several key functions, she explained. For one, examiners set high standards for banks through their policies and supervisory programs. They also play an important role in monitoring banks' internal processes and looking behind the numbers for weaknesses in governance, risk management, or internal controls that could expose banks to losses. Importantly, supervisors lend much-needed context and perspective by measuring a bank's performance against that of its peers while also considering the institution's unique circumstances, Raskin said.

More than just a model
"The expectations that I have described for both banks and examiners are not just hypothetical," said Raskin. Pointing to the many community banks that maintained their top-notch ratings throughout the crisis, she listed a few common traits, including moderate exposures to commercial real estate, strong earnings, and a limited reliance on noncore funding sources. In addition, she said, "many of these banks have effective boards of directors and strong and experienced management teams. It is important that examiners keep this in mind as they evaluate and refine their supervisory processes in the wake of the crisis."

April 22, 2011